At the Milken Institute Global Conference last week, several of the world’s top CIOs talked about taking the long view and the dangers of short-termism.
The panel included Chris Ailman, CIO of CalSTRS; Vicki Fuller and Scott Evans, CIOs for New York State and New York City, respectively; and Hiromichi Mizuno, CIO of Japan’s Government Pension Investment Fund.
Video credit: Milken Institute
The median U.S. public pension fund returned 1.24 percent in the 1st quarter of 2016, according to a report from Wilshire.
That level of return, if annualized, would fall short of most funds’ assumed rate of return. Most of the public pension funds in the study have target returns of 7.25 – 8 percent.
More from Bloomberg:
The results mean that public pensions, which typically target annual returns of 7 percent or greater, will have to make up ground the rest of the year. If they don’t, governments eventually have to pump more taxpayer money into the funds to make up for the shortfall. The modest returns following gains of 2.73 percent during the fourth quarter and a losses of 4.6 percent in the three months through September.
“You’d be going back to the contributor and saying we need to have more funding,” said Robert Waid, a managing director at Wilshire Associates in Santa Monica, California.
The Standard & Poor’s 500 stock index returned about 1.3 percent during the first three months of the year, while the MSCI index of international equities lost 3 percent. The Barclays U.S. Aggregate bond index gained 3 percent.
Public pensions with more than $5 billion in assets, which have more invested with hedge funds and private-equity funds, performed slightly worse than others. Large pensions logged a median 1.15 percent for the quarter, dragged down by their investments in hedge funds. Those investment vehicles lost 3.3 percent before fees for the quarter and 5.9 percent for the year ending March 31, according to Wilshire TUCS.
Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.
Tom DiChristopher of CNBC reports, The 2 and 20 hedge-fund model is dead:
The compensation model that has enriched hedge fund managers for years is not long for this world, CalSTRS Chief Investment Officer Christopher Ailman said Monday.
To find yield in the current low-interest-rate environment, CalSTRS has invested in select hedge funds. But Ailman said the pension fund is not paying the alternative investment class’s notoriously high fees.
“Two and 20 is dead. People have to understand that. That model has been broken,” he said during an interview on the sidelines of the Milken Institute Global Conference on CNBC’s “Squawk on the Street.” Ailman was referring to the typical hedge fund fee structure in which portfolio managers charge 2 percent of total asset value and 20 percent of the portfolio’s returns.
Investors pulled more than $15 billion from hedge funds in the first three months of the year, making it the worst quarter for managers in seven years, the Financial Times reported last month.
To be sure, CalSTRS has considerable heft to negotiate, being the nation’s second-largest pension fund with a portfolio valued at about $186.8 billion as of March 31.
“We have a size advantage,” Ailman said. “We already are negotiating. Our staff has put on their boxing gloves and gone in there and just laid it out, what we’re looking for.”
Ailman acknowledged that new funds will continue to ask small investors to pay 2 and 20, but said in most cases the split has come down.
CalSTRS is currently pursuing a risk-mitigation strategy, but not because it is worried about the broader market, he added.
“It’s all back to that point of having a balanced portfolio, being exposed to GDP growth, but then also having some balance on the other side because we are going to have U.S. recessions and we’re going to have global recessions,” he said.
“This is a low patch, but we think, overall, growth will come through.”
In my last comment on hedge funds under attack, I discussed why I think it’s insane to give any multibillion hedge fund 2 & 20 to manage assets, especially in a deflationary world where ultra low and negative rates are here to stay.
Paying 2 & 20 is even more insulting when hedge fund aren’t delivering on their promise. And when you have brand name fund like Tiger Global’s flagship Onshore fund declining 22% (gross) in the first quarter, it really stings to have to pay these guys any management fee whatsoever (long gone are the days where the Tiger fund was burning bright and I warned you to stop chasing after “Chase Coleman” and other hedge fund superstars getting crushed).
No wonder New York state’s pension leader is calling hedge fund fees ‘unfair’:
The chief investment officer of the New York state pension fund doesn’t like the fees hedge funds charge to manage money.
Vicki Fuller, who oversees the $185 billion New York State Common Retirement Fund, said the hedge fund industry’s “2 and 20” fee model is “unfair.”
“We’re looking at alternative structures,” Fuller told The Post on Wednesday while attending the Milken Institute Global Conference here.
While Fuller declined to provide specifics, some big pensions are feeling pressure to cut costs and have pushed hedge funds to lower their fees. Others including CalPERS, the largest US public pension plan, have pulled their money from hedge funds.
Traditionally, hedge funds pocket a 2 percent annual management fee and take an additional 20 percent of performance gains.
The New York state pension, the country’s third-largest, spent $113 million on hedge fund management fees in the fiscal year ended March 31, 2015. During that period, the pension had 4.5 percent of its assets in hedge funds, which generated a 5.9 percent return.
The hedge funds the pension has investments in include Bridgewater Associates, D.E. Shaw, GoldenTree Asset Management, Paulson & Co., Trian Fund Management and ValueAct Capital.
Unlike New York City’s public employee pension, which voted to exit its hedge fund portfolio, the state pension isn’t planning to yank its money from hedge funds, Fuller said.
Not sure Fuller’s team really knows what they’re doing when it comes to hedge funds. If I were her, I’d seriously consider bailing from hedge funds too and let these billionaires sell their summer homes to pay off the fees they’ve stolen accumulated over the years from their (no longer) patient clients.
I have strong views when it comes to hedge fund and private equity fund fees (at least PE funds have a hurdle rate and a clawback). I believe in paying for performance, not asset gathering. Period. I couldn’t care less who the manager is, how long they’ve been in business, how rich and famous they are. All this is irrelevant to me as I truly believe a lot of the good times are over for the world’s hedge fund and private equity billionaires which got away with murder for many years.
Now that hedge fund managers are losing their swagger, and institutional investors are waking up and redeeming from individual funds and funds of funds charging an extra layer of fees, it’s going to be a lot tougher for hedge funds to justify their fees.
I will let you listen to Chris Ailman’s remarks below. He’s right, large pensions aren’t paying 2 & 20 anymore (more like 1 or 1.5 & 15 if they have leverage to negotiate hard). This is especially true when it comes to investing in large, multibillion, liquid hedge funds strategies.
However, when it comes to an emerging hedge fund, it only makes sense to give them a 2% management fee to help them get off and running and cover fixed costs. Also, a lot of the less liquid strategies will still charge hefty fees because they won’t grow past a few hundred million dollars of assets under management (typically their investors are large family offices or small endowments looking for very niche strategies).
Lastly, and a bit critically, I don’t consider CalSTRS an expert in hedge funds. They were very late in the game, which is fine, and they certainly don’t have an external hedge fund program that matches more mature ones at Ontario Teachers’ Pension Plan or other large hedge fund investors in Canada who actually know what they’re doing in hedge funds.
I used to invest in CTAs, global macros and L/S Equity funds. I don’t think they’re the best way to generate consistent alpha in hedge funds. In fact, if you look at the last few years, the best hedge funds were multi-strategy funds (this year is much tougher for them). I understand why CalSTRS is investing in CTA and global macro funds for scalable “non-correlated” alpha but I think they need to review their entire hedge fund program which is still in its infancy.
By the way, all of you paying 2 & 20 to any hedge fund should carefully read my last comment on billionaires bearing stock tips.
The U.S. Treasury Department on Friday rejected the Central States Pension Fund’s proposal to cut member benefits by as much as 50 percent.
Renowned mediator Kenneth Feinberg made the decision.
Here’s why Fienberg rejected the plan, according to the Kansas City Star:
In a 10-page letter to the pension fund, Feinberg said it failed on three tests.
The proposal failed to reasonably show it would avoid the pension fund’s looming insolvency, it failed to distribute the benefits cuts equitably and notices to those covered by Central States were not written in a way that they would be understood by the average participant in the fund.
“We will not accept it. We cannot accept it,” Feinberg said during a conference call with reporters. “No benefit cuts are permitted pursuant to this law.”
Central States has about 400,000 members.
Photo by Bob Jagendorf via Flickr CC License
The Central States Pension Fund may cut its members’ benefits this month under rules brought forth by the Multiemployer Pension Reform Act (MPRA) of 2014.
The Act allows multiemployer pension plans to voluntarily cut their members’ benefits to improve solvency.
A new bill, introduced by Senate Democrats last week, adds a Yankee Wrinkle to the whole situation: it proposes that if a plan aims to cut its members’ benefits, the plan’s executives should also have their pay frozen.
More from the Hill:
A group of Democratic senators want to see pension executives suffer a pay cut if the plans they monitor cut benefits.
A new bill unveiled Tuesday takes square aim at executives of pension plans that are considering cutting benefits, as lawmakers want to ensure that top officials feel some of the resulting pain as well.
The cuts would impact hundreds of thousands of union workers, but the senators contend that top executives should have some skin in the game too. In a press release announcing the bill, the senators noted that the fund’s top executive made nearly $700,000 in 2014 and that the fund has also hired lobbyists to help make its case in Washington.
[…]
Under the new bill, pension fund executives would face a cut in their pay proportional to the steepest benefit cuts any retiree would face under their pension plans. Furthermore, no executives would receive a bonus while benefit cuts are in place, and pension plans seeking benefit cuts would be barred from spending money on lobbyists.
“Fund assets shouldn’t be spent on excessive salaries and compensation for Washington lobbyists while critical retirement benefits for ordinary folks are slashed,” added Sen. Claire McCaskill (D-Mo.), another sponsor. “That’s basic fairness, and it’s appalling that executives would give themselves a pat on the back and a bonus while hurting retirees.”
The bill – which sits in a Senate controlled by Republican lawmakers – is unlikely to go very far. But lawmakers from both parties are interested in limiting the pain of the multi-employer pension cuts.
Investment staffers at public pension funds are under-compensated relative to the market — and that’s dangerous to the long-term prospects of the funds, according to several top CIOs who spoke at the Milken Institute Global Conference this week.
If public pension funds don’t begin giving their staff higher wages, they won’t have the talent to meet return targets, according to the panelists.
U.S. pension funds could look to their Canadian peers for a roadmap.
More from ai-cio.com:
“If it doesn’t get fixed, no, you won’t meet the target rates of return. You won’t have the talent,” said Vicki Fuller, CIO of the $185 billion New York State Common Retirement Fund.
On a $1 billion private equity mandate, for example, New York’s fund might spend $30 million to $50 million in fees per year. The employee responsible for that mandate? “$150,000,” Fuller pointed out. “It doesn’t make sense.”
The net investment of increasing staff wages to effectively manage assets in-house would be paid off many times over, according to panelist Chris Ailman, CIO of California’s $187 billion teachers’ retirement system. He knows from experience.
“In the public markets, it costs us about one-tenth the cost to run money in-house as it does to hire an external manager,” Ailman said. “If we could run money in private markets and do direct deals, it would probably be 25 times cheaper.”
Ailman and Fuller lauded Canadian pension funds for solving the issue through arm’s-length governance structures and market-competitive wages.
Ron Mock, CEO of Ontario Teachers’ Pension Plan, earned C$4.3 million (US$3.4 million) in 2015, for example. His predecessor took home double that in 2013. At $133 billion, the fund has among the best long-term track records of any pension investor worldwide, net of expenses.
Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.
Barbara Shecter of the National Post reports, Canadians shouldn’t confuse CPP investment gains with higher pensions:
The Canada Pension Plan’s investment arm may be racking up impressive gains, but Canadians are mistaken if they think the portion they will be getting in retirement is growing at the same rate, says a new paper from the Fraser Institute.
“Unlike individual RRSP, TFSA, or pension accounts, there is no direct relationship between the rates of return earned in the CPPIB (Canada Pension Plan Investment Board) and the benefits received by eligible retirees,” authors Jason Clement and Joel Emes say in the paper to be released Thursday.
The Canada Pension Plan Investment Board invests money that is not needed to pay current CPP benefits. As such, its returns will provide indirect benefits to individuals who will ultimately retire, such as by reducing the need to raise contribution rates to sustain the pension scheme, the paper says.
An individual’s annual retirement benefits, however, are calculated based on a complex formula that takes into account, among other things, the contributions each worker makes to the CPP over the course of their working life, from age 18 to 65. The benefits are also capped at an average income level below what many recipients earned during their working lives.
So while the CPPIB has performed “reasonably well,” reporting an average rate of return of 7.9 per cent since 2000, the authors calculate that someone born after 1955, and who retires in 2021 or later, will receive a “modest” annual return on their contributions of around three per cent.
Any CPP-eligible worker born after 1971, and retiring in 2037 or later, will receive an annual return of just 2.1 per cent in retirement, the paper says.
These returns are far lower than the CPP investment arm’s 10-year real rate of return of 6.2 per cent, after expenses, and also below the four per cent real rate of return the Chief Actuary of Canada says is necessary for the CPP to remain sustainable.
“It’s fairly easy for average Canadians to confuse the returns earned by the CPP Investment Board (CPPIB), which is tasked with actively investing the investable funds of the CPP, with what they themselves might actually earn from their contributions to the CPP in the form of retirement benefits,” the authors write.
“Indeed, some advocates for the expansion of the CPP have conflated, or at least not clearly differentiated between, the rates of return earned by the CPPIB and the actual returns received by individual Canadian workers in the form of CPP retirement benefits.”
The recently elected federal Liberal government of Justin Trudeau ran on a platform of enhancing the national pension program to ensure all Canadians have an adequate standard of living in retirement.
The maximum CPP retirement benefit for new recipients at age 65 is $1,092.50 a month. The benefit is meant to replace about 25 per cent of pre-retirement income but reaches a maximum around $12,000 a year.
The Trudeau victory kick-started talk about enhancing the Canada Pension Plan, which Ottawa and the provinces discussed seriously in 2010.
When an agreement could not be reached, the Conservative government of the day subsequently studied targeted voluntary contributions to CPP, adhering to the view that mandatory national expansion could hurt the economy by placing a burden on businesses that would be forced to contribute.
If the CPP program is not expanded by 2018, Ontario’s Liberal government has pledged to forge ahead with the creation of a separate provincial pension plan that would bolster the national scheme.
The Fraser Institute paper published this week is the latest from the think-tank to question the rationale for expanding the national pension scheme. Recent papers challenged the view that the Canada Pension Plan is a low-cost operation due to economies of scale, and suggested Canadians already save adequately for retirement.
In the review and analysis of returns on CPP contributions, this week’s paper found that older Canadians — those who reached retirement between 1970 and 1979 — did substantially better than more recent retirees.
Their contribution rates were lower and workers at that time were required to contribute to the program for a shorter period, allowing these retirees to enjoy a rate of return of 27.5 per cent, according to the paper’s authors.The figures used to calculate returns don’t take into account payments received beyond base retirement benefits, such as survivor’s pension or death benefits.
You can read the full report by the Fraser Institute here. This report follows another one questioning the costs of running the CPP. I ripped into that report as did other pension experts who stated that study was deeply flawed.
Now we get another study from the Fraser Institute claiming Canadians don’t really see the benefits of expanding the CPP. Let me briefly give you my thoughts on this study:
Having said all this, I will concede something to the authors of this latest Fraser Institute study, we need a lot more transparency on the way CPP benefits are determined (apart from a simple video) and there should be an open discussion on whether benefits should be increased or premiums reduced (of course, enhancing the CPP means higher premiums and higher benefits).
I believe in prudent management of the CPP, which basically means saving for a rainy day (and there will be plenty of them in the future), but I also believe in fairness and transparency. For example, if someone is working well past 65 years old and contributing to the CPP, why are their benefits capped and why shouldn’t people who contribute more, receive more? These are all policy questions which need to be addressed by our provincial and federal governments, not the people managing the CPPIB.
I reached out to Bernard Dussault, Canada’s former Chief Actuary, to get his views on this study. Bernard was kind enough to share this with me:
By definition, the rate of return in respect of a cohort of contributors is the discount rate that renders the present value of all contributions made for this cohort during its active life equal to the present value of all benefits paid to this cohort during its whole retirement benefits period (i.e. ending with the death of the last survivor of the cohort).
Generally speaking (e.g. assuming stabilized conditions), if a pension plan is financed on:
- a fully funded basis, then thee rate of return corresponds to the average (over the period running from the first contribution made to the last pension benefit paid) rate of return on the concerned fund;
- a partial funded basis, let say p% (for the CPP “p” is close to 15%), then the rate of return corresponds to [ (p)*i + (1-p)*e ], where:
- “i” corresponds to the average (over the period running from the first contribution made to the last pension benefit paid) rate of return on the concerned “partial” fund;
- “e” correspond to the average (over the active contribution period) rate of increase in the contributory employment earnings of the concerned cohort (i.e. the compounded increase of the salary and the population increase rates).
As indicated in Table 21 on page 49 of the 26th actuarial report on the CPP (http://www.osfi-bsif.gc.ca/Eng/Docs/cpp26.pdf), the nominal internal return for the cohort of CPP contributors born in 2010 amounts to 4.5%, while the nominal rate on the CPP fund is 6.2% (i.e. the sum of the 4% real rate plus the 2.2% inflation rate).
The 4.5% return on CPP contributions is obviously less than what it would be, i.e. 6.2%, if the CPP were fully funded. It is not because from 1966 to 1995 contributions to the CPP were made at a level lower than the CPP full cost rate, i.e. about 6%.
Besides, I consider that a lifetime guaranteed return of 4.5% is much appreciable:
- not only because it applies to all members of the 2010 cohort taking into account the absence of longevity risk;
- but also because few individuals (if any), irrespective of their investment expertise, would be in a position to achieve a 4.5% rate of return on average from age 18 to death.
I thank Bernard for sharing his expert insights with my readers.
In its first U.S. transportation investment, CalPERS has bought a 10 percent stake in the Indiana Toll Road Concession Company LLC, which operates the 157-mile Indiana Toll Road.
It bought the share from IFM Investors.
More from a release:
“This solid, long-term investment represents our first foray into a transportation asset in the United States,” said Paul Mouchakkaa, Managing Investment Director for CalPERS’ Real Assets program. “We continue to make progress building up this important program, and the ITRCC aligns well with our recently adopted strategic plan for real assets.”
The ITR spans northern Indiana, from its border with Ohio to the Illinois state line near Chicago. ITRCC has the exclusive right to collect revenues from the toll road for the next 65 years. IFM Investors continues to hold more than 85 percent of ITRCC. Pricing and details of the purchase are not being released at this time.
The role of CalPERS’ Infrastructure program is to hold ownership of essential infrastructure assets that provide predictable returns with moderate long-term inflation protection. Infrastructure also acts as an economic diversifier to equity risk in the portfolio. With this purchase, the program makes up slightly more than one percent of the total fund, with a net asset value of approximately $3.1 billion.
Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.
Saijel Kishan of Bloomberg reports, Hedge Funds Under Attack as Steve Cohen Says Talent Is Thin:
In less than seven days, hedge funds have been subject to a three-pronged attack by some of the biggest names in finance.
Steve Cohen, the billionaire trader whose former hedge fund had racked up average annual returns of 30 percent before pleading guilty to securities fraud three years ago, became the latest critic of the business, saying he’s astounded by its shortage of skilled people.
“Frankly, I’m blown away by the lack of talent,” Cohen said at the Milken Institute Global Conference in Beverly Hills, California, on Monday. “It’s not easy to find great people. We whittle down the funnel to maybe 2 to 4 percent of the candidates we’re interested in. Talent is really thin.”
‘Very Hard’
Cohen’s comments come after billionaire Warren Buffett said over the weekend that large investors should be frustrated with the fees they pay hedge funds, which fail to match the returns of index funds. Daniel Loeb, founder of hedge fund Third Point, said last week that industry performance this year was “catastrophic” and that funds were in the early stages of a “washout.”
Cohen, who had started his hedge fund SAC Capital Advisors in 1992, said the business has “gotten crowded” with too many managers following similar strategies. Hedge funds seem to think that by hiring skilled people, they can “magically” generate returns, he said.
“It’s very hard to maximize returns and maximize assets,” said Cohen, who runs $11 billion Point72 Asset Management. It’s difficult to balance size with carefully managing an organization and delivering good risk-adjusted returns, he added.
Cohen rarely speaks publicly at industry events. He made the comments on a panel discussion with money managers Cliff Asness and Neil Chriss.
’Cost of Being Excellent’
SAC Capital agreed to return outside money to clients as part of a 2013 agreement with U.S. prosecutors targeting insider trading on Wall Street. The firm was renamed Point72 and now manages Cohen’s fortune. He wasn’t accused of wrongdoing.
Point72 President Doug Haynes said in October that there could be more closures and money pulled out of the hedge fund business as the “cost of being excellent” in the industry keeps rising.
Cohen said at the conference one of his biggest worries last year was that his firm might become the victim of an indiscriminate market selloff as other funds endured troubles and reduced risk. He said his worst fears were realized in February when his firm lost 8 percent. Global stocks fell about 1 percent that month.
Earlier Monday, hedge funds came under criticism at the conference on the heels of Buffett’s comments at his firm’s annual shareholder meeting on Saturday.
High Pay
Chris Ailman, who runs investments at the $187 billion California State Teachers’ Retirement System, said in a Bloomberg Television interview that the hedge fund industry’s fee model is “broken” and “off the table” for large institutional investors. Chriss, founder of hedge fund Hutchin Hill Capital, said investors will pull out of funds that aren’t giving them returns to justify the fees.
Jagdeep Singh Bachher, chief investment officer of the University of California’s $97.1 billion of endowment and pension assets, said paying high hedge fund fees for mediocre performance is “absurd.”
The only money managers worth high fees are those who have uncovered “unique situations” in financial markets, he said Monday at a meeting of the Board of Regents’ investment committee. The endowment said it’s consolidating managers in its $4.7 billion absolute return portfolio.
The $8.7 billion endowment lost 4.2 percent in the first nine months of the fiscal year through March 31, staff told trustees. Private equity gained 9.2 percent while absolute return was down 5.4 percent.
‘Giant Ripoff’
Janus Capital Group Inc.’s Bill Gross joined the chorus, tweeting Tuesday that “hedge fund fees exposed for what they are: a giant ripoff. Forget the 20 – it’s the 2 that sends investors to the poorhouse.”
Hedge fund managers are among the highest paid in the finance industry, traditionally charging clients 2 percent of assets as a management fee and taking 20 percent of profits generated. Buffett described the fee structure as “a compensation scheme that is unbelievable” to him.
Since the global financial crisis, some managers have cut fees in exchange for getting larger investments from clients and locking their money up for longer periods. Even so, New York City’s pension fund for civil employees voted last month to end investing in hedge funds, determining that they didn’t perform well enough to justify high fees.
American International Group Inc., the insurer burned by losses on hedge funds, is scaling back from those investments. It has submitted notices of redemption for $4.1 billion of those holdings through the end of the first quarter.
Worst Start
Cohen said he was amazed that investors aren’t more demanding, while noting the irony of his remark since he now runs a family office. He said pension plans and endowments tend to follow trends instead of being forward thinking.
The $2.9 trillion hedge fund business is having its worst start to a year in terms of returns and client withdrawals since 2009, when financial markets were reeling from the global financial crisis. Managers including Bill Ackman, John Paulson and Crispin Odey posted declines of at least 15 percent in the first three months in some of their funds.
Loeb said in a quarterly letter that most money managers were “caught offsides at some or multiple points” since August. That month, China’s surprise currency devaluation sent shock waves across markets.
Cohen said most people at his Stamford, Connecticut-based firm are not very good at timing when to invest or exit markets, though they are adept at picking stocks. He said external hires account for 20 percent of headcount at Point72, which prefers to groom analysts and money managers internally.
The Point72 founder said there are parts of the world where there are opportunities to generate more alpha, which are profits above a benchmark index, than in the U.S. His firm has offices in cities including Hong Kong and London.
Cohen, who under a settlement with regulators could manage outside capital again as soon as 2018, said he didn’t see the crowding problem in the hedge fund business easing any time soon.
“This industry has been around in a real way for 25, 30 years and excess profits get competed away in one way or another,” he said. “More people are going to enter the business and drive it down. It’s starting to happen now and will probably continue to happen. That’s a normal industry cycle.”
Steve Cohen is right, there’s a tremendous amount of competition in the hedge fund world and real talent is thin (or enjoying the freedom of blogging after a long stint at SAC Capital). But he’s laying it on thick here for marketing reasons for his new fund which he will eventually manage (just like Ray Dalio does when he touts radical transparency and his Navy SEALs at Bridgewater).
Interestingly, one of my buddies in Montreal who left the pension industry and got a Masters of Science in Predictive Analytics from Northwestern University now works in the insurance industry and tells me he sees SAC and other top hedge fund recruiters at data analytics conferences along with those from Google and Amazon. He already has a Masters in Finance and a CFA but tells me straight out: “Top hedge funds don’t care about these qualifications, they are looking for specific qualifications and don’t really like traditional finance types.”
Anyways, back to Steve Cohen’s remarks. I was utterly shocked to learn his personal fund was down 8% in February but it shows you how brutal this environment is even for the perfect hedge fund predator. When you see top multi strategy funds like Cohen’s, Ken Griffin’s Citadel and Izzy Englander’s Millennium losing big in one month, you know it’s beyond brutal out there for top hedge funds.
What are some of the structural issues plaguing these top hedge funds? One of them most definitely is crowding. Cohen said hedge fund crowding caused his fund’s major February loss:
Billionaire investor Steven Cohen said that too many hedge funds placing the same types of bets contributed to sharp losses for his $11 billion Point72 Asset Management earlier this year.
“One of my biggest worries is that there are so many players out there trying to do similar strategies,” Cohen said Monday, speaking at the Milken Institute Global Conference in Los Angeles.
“If one of these highly levered players had a rough run and took down risk, would we be collateral damage?” Cohen said. “In February we drew down 8 percent which for us is a lot. My worst fears were realized.”Point72 has rebounded to a return of approximately zero for the year, according to a person familiar with the situation.
Cohen also commented on the hedge fund industry’s relatively large size and meager recent returns, saying that both investors and their clients were willing to tolerate lower performance.
“When this business started, guys took pride in the returns that they generated. Guys would make 20, 25, 30 percent,” said Cohen, known for generating similar returns himself. “Now it’s about trying to figure the intersection between assets under management and what investors would be willing to accept.”
In a world of ultra low and negative rates, hedge fund superstars can kiss those 20, 25 and 30 percent returns of the past goodbye, it’s never going to happen. They too have to prepare for lower returns which is why pensions need to brace for the new normal of lower neutral rates and squeeze hedge funds hard on fees.
That brings me to the other structural factor plaguing mostly large, well-known hedge funds. If the deflation tsunami I’ve been warning about comes true, and ultra low or negative rates are here to stay, this means these large hedge funds are going to have to deal with unimaginable volatility in public markets. This is the type of volatility that has confounded the best of them in the past and size is an issue when you’re trying to deliver great risk-adjusted returns in this environment.
Let me be more blunt. I think a lot of hedge funds are getting way too big for their own good and more importantly, for that of their investors. When Cohen says “now it’s about trying to figure the intersection between assets under management and what investors would be willing to accept,” he’s absolutely right.
What he neglects to say is that many of the bigger hedge funds deliberately focus a lot more on growing assets under management than their risk-adjusted returns and that’s what frustrates their investors which dole out 2 & 20 or 1.5 and 20 in management and performance fees (in his heyday, Cohen was charging 3 & 50 to his investors). It’s that 2% management fee on multibillions which really stings when managers are underperforming.
Earlier this week we learned AIG, burned by losses on hedge funds, submitted notices of redemption for $4.1 billion of those holdings through the end of the first quarter. Last month, New York City’s largest pension followed CalPERS and shut down its hedge fund program, telling managers to sell their summer homes and pay back all those hefty fees.
And to add insult upon injury, the Oracle of Omaha launched an epic rant against Wall Street tearing into hedge funds, their fees and the entire investment consulting and pension industry to pieces:
Just before lunch at the Berkshire Hathaway annual meeting on Saturday, Warren Buffett unloaded what he called a “sermon” about hedge funds and investment consultants, arguing that they are usually a “huge minus” for anyone who follows their advice.
The Berkshire chairman has long argued that most investors are better off sticking their money in a low-fee S&P 500 index fund instead of trying to beat the market by employing professional stockpickers. He used the annual meeting to update the tens of thousands in attendance—and others watching via a webcast–about his multi-year bet with hedge fund Protege Partners. The bet, initiated by the New York fund back in 2006, was that over a decade, the cumulative returns of five fund-of-funds picked by Protege would outperform a Vanguard S&P 500 index fund, even when including fees.
Mr. Buffett showed a chart comparing the cumulative returns of the two sides of the bet since 2008. As of the end of 2015, the S&P 500 index fund had a cumulative return of 65.7%, outdoing the hedge fund teams’s 21.9% return. The S&P has outperformed in six of the eight individual years of the bet too.
The chart was preamble to the real point Mr. Buffett wanted to make: that passive investors can do better than “hyperactive” investments handled by consultants and managers who charge high fees.
“It seems so elementary, but I will guarantee you that no endowment fund, no public pension fund, no extremely rich person” wants to believe it, he said. “They just can’t believe that because they have billions of dollars to invest that they can’t go out and hire somebody who will do better than average. I hear from them all the time.”
But he was just getting started.
“Supposedly sophisticated people, generally richer people, hire consultants, and no consultant in the world is going to tell you ‘just buy an S&P index fund and sit for the next 50 years.’ You don’t get to be a consultant that way. And you certainly don’t get an annual fee that way. So the consultant has every motivation in the world to tell you, ‘this year I think we should concentrate more on international stocks,’ or ‘this manager is particularly good on the short side,’ and so they come in and they talk for hours, and you pay them a large fee, and they always suggest something other than just sitting on your rear end and participating in the American business without cost. And then those consultants, after they get their fees, they in turn recommend to you other people who charge fees, which… cumulatively eat up capital like crazy.”
Mr. Buffett said he’s had a hard time convincing people of this case.
“I’ve talked to huge pension funds, and I’ve taken them through the math, and when I leave, they go out and hire a bunch of consultants and pay them a lot of money,” he said, earning a laugh from the crowd. “It’s just unbelievable.”
“And the consultants always change their recommendations a little bit from year to year. They can’t change them 100% because then it would look like they didn’t know what they were doing the year before. So they tweak them from year to year and they come in and they have lots of charts and PowerPoint presentations and they recommend people who are in turn going to charge a lot of money and they say, ‘well you can only get the best talent by paying 2-and-20,’ or something of the sort, and the flow of money from the ‘hyperactive’ to what I call the ‘helpers’ is dramatic.”
A passive investor whose money is in an S&P 500 index fund “absolutely gets the record of American industry,” he said. “For the population as a whole, American business has done wonderfully. And the net result of hiring professional management is a huge minus.”
Mr. Buffett has long had a testy relationship with Wall Street, and he’s positioned himself for decades as an outsider to the world of New York finance. In addition to repeatedly attacking the fees charged by hedge funds and investment professionals, he’s criticized the tactics of activist shareholders, the danger of derivatives and the heavy use of debt by private-equity firms.
The antipathy can run in the opposite direction as well. As our Anupreeta Das noted in an article last year, many on Wall Street believe the Berkshire chairman to be a hypocrite. They accuse him of hiding behind the image of a folksy, benevolent investor while pursuing some of the tactics and investing in some of the companies that are the targets of his attacks.
On Saturday, Mr. Buffett worked in a fresh plug for a book he’s been recommending for decades, “Where Are the Customers’ Yachts?,” by Fred Schwed. The title comes from the story of a visitor to New York who was admiring all the nice boats in the harbor, and was told that they belonged to Wall Street bankers. He naively asked where the bankers’ clients kept their boats. The answer: They couldn’t afford them.
“All the commercial push is behind telling you that you ought to think about doing something today that’s different than you did yesterday,” Mr. Buffett told his shareholders. “You don’t have to do that. You just have to sit back and let American industry do its job for you.”
Berkshire Vice Chairman Charlie Munger jumped in to offer a counterpoint, of a sort:
“You’re talking to a bunch of people who have solved their problem by buying Berkshire Hathaway,” he said. “That worked even better.”
From 1965 through the end of last year, Berkshire shares have risen 1,598,284%, compared to the 11,355% return on the S&P 500.“There have been a few of these managers who have actually succeeded,” Mr. Munger said. “But it’s a tiny group of people. It’s like looking for a needle in a haystack.”
Mr. Buffett conceded that point, but concluded the first half of the day’s proceedings by saying that Wall Street was better at salesmanship than investing.
“There’s been far, far, far more money made by people in Wall Street through salesmanship abilities than through investment abilities,” he said. “There are a few people out there that are going to have an outstanding investment record. But very few of them. And the people you pay to help identify them don’t know how to identify them. They do know how to sell you.”
I couldn’t agree more with Buffett and Munger on that last point and I too have railed against useless investment consultants that have hijacked the entire investment process at U.S. public pensions, typically recommending hot hedge funds their clients should be avoiding.
But while I don’t pity hedge fund managers, I think Buffett’s epic rant was somewhat harsh for a few reasons:
Still, there’s no denying Buffett made devastating points when he slammed hedge funds, consultants and pensions hard in his epic rant
A new bill, filed on Tuesday by Illinois Sen. Daniel Biss, aims to make private equity agreements more LP-friendly.
HB6292 bears resemblance to a recent California bill, but goes even further.
Naked Capitalism describes the bill:
It is a vastly more ambitious and painstakingly drafted bill than its California counterpart, AB 2833.
A key difference is that Biss’ bill opens new terrain by requiring disclosure of some of the most troubling terms of private equity limited partnership agreements, specifically, the indemnification provisions, the clawback language and management fee waivers.
[…]
HB6292 also lifts the veil on management fee waivers. […] HB6292 requires both that the management fee waiver provisions in limited partnership agreements (including all definitions necessary to understand how the provision operates) be among other things, published material on its website, and “the amount of all management fee waivers made” be disclosed annually.
The bill also provides for disclosure of the signature block of the executed limited partnership agreement.
On the fee transparency front, while the Illinois bill focuses on issues similar to Chiang’s legislation, the approach is dramatically different. HB6292 has an exacting set of definitions. I spoke to Senator Biss about his approach and whether he had conferred with Chiang’s office. Biss said that he’d not known about the shortcomings with private equity disclosure until Chiang announced his intention to sponsor legislation last fall:
I thought I should learn more about it. I spoke to as many people as I could. The more I learned, the more troubling I found it. I didn’t think it was sustainable in the long run. I thought there was an opportunity and I wanted to play a role in this change.
